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carry trade

Interest rates and inflation peaked in the UK and US in 1980. Over the following 29 years interest rates declined in the US and UK from 20% to 1% generating a long uplift in the value of equities and other assets.

Japan became a global source of very cheap investment capital in the mid 90s as a consequence of ultra low-interest rates, the declining value of the Yen and the emergence of hedge funds meant that it became risk free to borrow Yen and invest in investment assets with much higher yields.

The Dow closed at under 1,000 in 1980; twenty-seven years later it reached nearly 14,000. The FTSE rose from 500 in 1980 to nearly 7,000 in 2007.

By 2000, monetary policy was being used to avert possible recessions, rather than as had been the practice, to stimulate the way out of one. This policy created additional credit, at a time when credit was already cheap and plentiful The super liquid conditions stimulated the securitization of loans by banks and the creation of many new financial derivatives outside of the control of central banks .

Inflationary consequences of the asset boom on consumer prices were absent probably because of the unprecedented productivity enhancement effects of computerization and the internet reinforced by the availability of ultra-cheap manufactured goods from China.

The point was reached where no more financial air could be blown into the bubble and it began to contract. Interest rates have now been declining for nearly thirty years, In the case of the UK and US they cannot go any lower.

The last upward cycle in interest rates began in 1950 and lasted thirty years and coincided with an era of great prosperity and growth, although the Dow ‘only’ increased 275% in those thirty years.

Here’s to the next thirty years…..

I wrote that in February 2010. What happened next?

January 2013, the credit bubble is inflating again. Worldwide, bank shares have typically doubled over the past few months. An unexceptional example is Lloyds Group whose shares were 35p in June 2012 and are now 50p i.e. Lloyds market cap has doubled to £35 billion for no discernible reason other than credit easing (mainly quantitive easing).

Junk bond yields are at an all time low, most stock markets are have risen sharply seemingly both because of credit easing – fundamental prospects haven’t changed, junk is junk, austerity is austerity, flat or declining gdp is the story in most places.

The financial establishment appear to have won enough to fight another day. Newspapers report any signs of rising property prices as ‘good’ news. Similarly more easily available consumer credit is reported as a ‘good’ story.

Let’s keep it simple. Much of the fund management ‘industry’ earns income as a percentage of assets under management – AUM. In the past six months the majority of investment assets have risen in price. The reason they have risen in unison is because of cheap and easy credit (the lowest interest rates for 300 years, mind-boggling central bank money printing via QE).

The effect of this is to sharply boost the income of financial services, a windfall which will no doubt be portrayed as the consequences of cleverness and skill (a simple lie) The resultant recovery in profits and bonuses becoming a’ good’ financial recovery story in 2014.

Interest rates and inflation peaked in the UK and US in 1980. Over the following 29 years interest rates declined in the US and UK from 20% to 1% generating a long uplift in the value of equities and other assets.

Japan became a global source of very cheap investment capital in the mid 90s as a consequence of ultra low-interest rates, the declining value of the Yen and the emergence of hedge funds meant that it became risk free to borrow Yen and invest in investment assets with much higher yields.

The Dow closed at under 1,000 in 1980; twenty-seven years later it reached nearly 14,000. The FTSE rose from 500 in 1980 to nearly 7,000 in 2007.

By 2000, monetary policy was being used to avert possible recessions, rather than as had been the practice, to stimulate the way out of one. This policy created additional credit, at a time when credit was already cheap and plentiful The super liquid conditions stimulated the securitization of loans by banks and the creation of many new financial derivatives outside of the control of central banks .

Inflationary consequences of the asset boom on consumer prices were absent probably because of the unprecedented productivity enhancement effects of computerization and the internet reinforced by the availability of ultra-cheap manufactured goods from China.

The point was reached where no more financial air could be blown into the bubble and it began to contract. Interest rates have now been declining for nearly thirty years, In the case of the UK and US they cannot go any lower.

The last upward cycle in interest rates began in 1950 and lasted thirty years and coincided with an era of great prosperity and growth, although the Dow ‘only’ increased 275% in those thirty years.

Here’s to the next thirty years…..

I wrote that in February 2010. What happened next?

January 2013, the credit bubble is inflating again. Worldwide, bank shares have typically doubled over the past few months. An unexceptional example is Lloyds Group whose shares were 35p in June 2012 and are now 50p i.e. Lloyds market cap has doubled to £35 billion for no discernible reason other than credit easing (mainly quantitive easing).

Junk bond yields are at an all time low, most stock markets are have risen sharply seemingly both because of credit easing – fundamental prospects haven’t changed, junk is junk, austerity is austerity, flat or declining gdp is the story in most places.

The financial establishment appear to have won enough to fight another day. Newspapers report any signs of rising property prices as ‘good’ news. Similarly more easily available consumer credit is reported as a ‘good’ story.

Let’s keep it simple. Much of the fund management ‘industry’ earns income as a percentage of assets under management – AUM. In the past six months the majority of investment assets have risen in price. The reason they have risen in unison is because of cheap and easy credit (the lowest interest rates for 300 years, mind-boggling central bank money printing via QE).

The effect of this is to sharply boost the income of financial services, a windfall which will no doubt be portrayed as the consequences of cleverness and skill (a simple lie) The resultant recovery in profits and bonuses becoming a’ good’ financial recovery story in 2014.

The military have learned to exert some control over media reports of their operations by ‘embedding’ journalists into operational units. Embedded journalists are not free to choose where they go and what they see, instead they have to remain with the unit they are embedded into and to the extent that they identify with the culture of the unit they are in, they lose a critical measure of objectivity.

Currently, the crisis of the financial establishment is largely reported in the financial press and financial columns by journalists effectively embedded in the financial establishment. This is exemplified clearly in the extent to which the Lex column has itself, become embedded in the financial establishment. Who benefits from the absence of robust criticism of a rotten system?

Is The Financial Times is an example of a newspaper dependant upon the financial establishment for sources of news. Is the F.T. the new Pravda* ?

Today, Lex writes about the revival of the ‘carry trade’. The borrowing of low-yielding currencies to buy in a higher yielding one. After a rambling account of the current revival Lex concludes without an explanation. But Lex comes close to stumbling on the only rational explanation when he states:

“For the truth is that carry trade opportunities should not exist at all: the whole point of flexible exchange rates is to rebalance things when interest rates get out of whack”

There is only one explanation which fits and that is for one significant investing class, the carry trade is a penalty free trade.

A carry trade by a fund whose managers would keep 20% of any profit but would bear no personal losses if it became loss making.

Three years ago equities and property were moving up in tandem, a continuation of the trend since 2003 . By this time, all other tradeable capital assets worldwide, equities, property, commodities, also moved as one, all charts looked the same. Anything sold because it looked over valued continued to move up at the same pace as its replacement.

In the mid 1990s the Japanese Central Bank cut interest rates to 1%. Borrowing at around 1% and investing in average yielding investment assets would have provided an automatic 4-5% gain, a license to print money were it not for the potentially ruinous exchange rate losses if the Yen moved against your invested currency. There was a solution though.

Set up and manage an unregulated investment fund. Use smoke and mirrors and nonsensical jargon to give the impression that what you were doing was ultra sophisticated and highly skilled and call it a hedge fund. As manager you would take 20% of any profits the fund made over a modest bench-mark. Should there be losses, the fund i.e. your investors, would bear 100 % of them, but you would still take a 2% management fee. Only your investors could lose. A perfect vehicle for the perfect trade, gambling other peoples money on terms where you win very large if your bets come right, but only win a little if they don’t.

In the ensuing years hedge funds proliferated, and the Ponzi nature of their collective activities resulted in spectacular profits for their managers.

At the end of 2006 worldwide asset prices seemed precipitously high, driven up by the carry trade and liquidity bubbles blown from the shadow banking system. In trying to identify a safe haven investment asset which had not inflated like all the others, German residential property caught my attention.

I decided to invest in German residential property, which was relatively cheap on two counts, the Euro was undervalued against Sterling, and the German property market had gone nowhere for 15 years.

In 1992 an average apartment in London would have ‘bought’ .7 of an equivalent one in Frankfurt, but by 2006 that same London apartment had become worth 2 of the Frankfurt apartments. This was the result of the appreciation of Sterling against the Euro, combined the effects of an inflated property market in the UK, and a static one in Germany.

Anyone fully invested since the March lows this year is now be sitting on a 60- 100% gain. Time to sell maybe, but the question of where to store the value created also arises again. And once again, with all asset classes inflating in unison, I have begun searching a new un-inflated lifeboat.